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Tuesday, May 10, 2011

CVS CEO: Papa Don’t Preach, I’m Keeping My PBM

On last week’s earning call, Larry Merlo, President and CEO of CVS Caremark (NYSE:CVS), offered a stinging rebuke to the company’s critics. He stated that “there are no plans to split up the company” and bashed “certain well-funded special interest groups” that are making “false, unfounded and misleading accusations regarding CVS Caremark to the media and to government officials.”

Folks, if you read only one earnings call transcript this year, then make it this one. Key excerpts after the jump.

Just don’t forget that Mr. Merlo comes from pharmacy retail business, which increasingly depends on the PBM relationship. See my latest calculations in the chart below showing that 27% of CVS Caremark’ retail prescription revenues now come from CVS Caremark’s PBM business.

I’ll take him at his word regarding the break-up. If the PBM business turns around in 2012, then the pressure to split will ease. If not…

Pembroke Consulting or Gerson Lehrman Group clients should feel free to schedule phone calls with me for additional comments beyond what I discuss in this post.As always, I encourage you to read the primary sources:

“Now before getting into the business review, let me address the speculation with regards to the future direction of our company, speculation that has been publicized in both the press and the investment community. I want to hit this topic head on to clarify any misperceptions in the marketplace and set our story and our focus straight. Now despite conjecture in the marketplace, there are no plans to split up the company.”

The chart below shows my computation of the revenue synergy for the CVS retail pharmacy business. More precisely, the chart measures the share of CVS retail pharmacy prescription revenues from people whose pharmacy benefit is administered by CVS Caremark's PBM business. My computation method is described at the bottom of the post. (Click the chart to enlarge it.)

As you can see, share hit a new high of 27% in the first quarter. If I am reading the footnotes correctly, only about one-fifth comes from Maintenance Choice, i.e., about 6% of the 27%.

CALLING OUT THE CONFLICTED

Here's an excerpt of Mr. Merlo’s statement about the purported conflict:

“For more than 2 years, certain well-funded special interest groups with specific agendas, agendas unrelated to the protection of consumers have been making false, unfounded and misleading accusations regarding CVS Caremark to the media and to government officials. Their goal is to pressure us to change certain elements of our business practices and service offerings, and I can unequivocally say that these changes would not benefit consumers. They would instead result in reduced choice and increased prices for payers and consumers.

Our offerings such as Maintenance Choice afford consumers greater choice and improved health outcomes, while reducing costs in a highly competitive Retail and PBM marketplace. And we do this without improperly steering members to CVS Retail pharmacies, a false accusation that remains unfounded. These accusations continue to be repackaged and repeated by special interest groups in the media and in letters to regulators. But none of the accusations have ever been substantiated, and we remain highly confident in the integrity of our business practices.”

I’m pretty sure he is referring to the self-interested, borderline-slanderous statements made by NCPA and various attorneys who are suing CVS Caremark. Some of these comments can be found on the NCPA's inaptly named PBM Resources web page.

Independent pharmacists have stirred up the mud, but they may be wrongly pointing the finger at a PBM instead of the payers. Re-read Pepsi, CVS Caremark, and the FTC to understand why there may be more smoke than fire here.

FWIW: ESTIMATING RETAIL RX REVENUES FROM PBM BENEFICIARIES

CVS Caremark reports an accounting item called “Intersegment eliminations,” which is defined in its earnings release as follows:

“Intersegment eliminations relate to two types of transactions: (i) Intersegment revenues that occur when Pharmacy Services segment customers use Retail Pharmacy segment stores to purchase covered products. When this occurs, both the Pharmacy Services and Retail Pharmacy segments record the revenue on a standalone basis, and (ii) Intersegment revenues, gross profit and operating profit that occur when Pharmacy Services segment customers, through the Company's intersegment activities (such as the Maintenance Choice(TM) program), elect to pick-up their maintenance prescriptions at Retail Pharmacy segment stores instead of receiving them through the mail. When this occurs, both the Pharmacy Services and Retail Pharmacy segments record the revenue, gross profit and operating profit on a standalone basis.”

I view these eliminations as a proxy for measuring the revenues to a CVS retail pharmacy when it fills a prescription for the beneficiary whose prescription benefit is managed by a CVS-owned PBM. In most cases, the PBM also recognizes revenues for these prescriptions because the PBM considers itself to be a principal in the transaction. The relevant PBMs are Caremark Rx, AdvancePCS, PCS Health Systems, Pharmacare (legacy CVS), and RxAmerica (legacy Long’s). Intersegment eliminations were reported to be $2,721 billion in the first quarter of 2011.

The denominator of the computation comes from the prescription revenues of CVS Caremark’s Retail Pharmacy segment. Net revenues in the segment were reported to be $14,587 billion in the first quarter of 2011, of which 69.1% were in the pharmacy. Hence, prescription revenues were $10,080.

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